Tackle illicit financial flows for the new bottom billion

July 13th, 2011

Jon Baldock/Flickr

Poverty ain’t what it used to be, nor for that matter where it used to be either. As the nature and location of poverty continues to change, the illicit financial flows agenda becomes all the more important for development.

Historically, the vast majority of people living on less than a dollar a day (or $1.25, where the World Bank’s line is now drawn) did so in low-income countries (LICs); that is, in countries with per capita gross national incomes less than $1005. So: income-poor people lived in income-poor countries. Simples. And true: twenty years ago, 93% of those in this extreme poverty lived in LICs.

Unsurprisingly, this characterisation of poverty gives rise to policy responses that focused on moving whole countries out of poverty. Paul Collier’s hugely influential The Bottom Billion was an important part of this analysis, highlighting around 60 countries which had experienced little growth in the 1980s and 1990s. The policy prescriptions emphasise the need for these countries to escape a series of traps, through, inter alia, better resource management, better conflict management and greater infrastructure investment.

As Andy Sumner of the UK’s Institute for Development Studies showed last year, however, the location of income poverty has shifted. The ‘New Bottom Billion’ – in fact, three quarters of the poorest 1.3 billion people – now live in middle-income countries (MICs).

Of course, this is about country graduation rather than mass migration. Sumner and Charles Kenny from the Centre for Global Development have now looked at the most recent World Bank assessment. As they wrote on The Guardian’s development website, this shows that 28 countries have graduated from LIC to MIC since 2000 – leaving just 35.

Partly this is a story about economic growth, raising countries about the (inevitably arbitrary) World Bank per capita income line that defines ‘low income’. But there is a more substantive component to the story also: that, increasingly, people living in income-poverty are doing so in countries that are not themselves (as) income-poor.

In short-hand, here’s why this matters. If poverty was largely about states that are poor, and often failing to grow, then one set of responses makes sense; and it could be argued that addressing illicit financial flows, or even building an effective tax system, was a second-order issue compared to – for example – addressing civil wars. (You might disagree, and so might I; but this would be a common view at least.)

As we understand that poverty is about people living at the wrong end of inequality within countries that are not so poor, however, we are confronted with a more complex – and political – problem.

Sumner and Kenny discuss one of the most recent graduates from LIC to MIC status, Ghana: “Twenty years of growth in Ghana has reduced the number of people living on $1.25 or less from just over 7 million to just under 7 million – and inequality (as measured by the Gini coefficient) rose significantly.” Despite some very positive developments in a number of human development indicators,Ghana’s graduation clearly does not imply an end to poverty.

The other graduate is Zambia, due to the boom in copper prices. The great majority of its citizens have failed to benefit, however. This reflects both direct problems of opacity and bad governance in the exploitation of these resources, and indirectly wider governance issues.

Christian Aid research (p.23) has shown that half the country’s copper exports in 2008 were marked at customs for Switzerland. Had Zambia received the export prices that Switzerland did, GDP would have been closer to $25 billion than the $14 billion that was recorded. That same year, the World Bank records GDP per capita of $1,140 but most recent data (2004) showing nearly two thirds of the population living on less than $1.25 per day.

Identifying poverty in middle-income countries requires policymakers to consider two main issues: first, in economic terms, why has growth failed to translate more broadly into poverty reduction? And second, what are the political underpinnings of that failure?

Both of these questions demand detailed analysis, but we know some answers already. Our recent research on growth and inequality confirms the rather obvious hypothesis that not all growth is equal. Further work is needed, but it seems clear that certain factors influence systematically the extent to which growth reduces or exacerbates inequality. Suggestive findings include that higher education levels, lower gender inequality in labour participation and stronger democratic processes may support inequality-reducing growth – as well as being valuable directly, of course.

The key, perhaps, is whether there are effective systems and structures of political representation in place, so that people’s views are heard and responded to – or not, because political marginalisation is likely to promote greater economic inequality (see for example the important work of Frances Stewart on inequalities between groups).

Creating effective political representation is not straightforward, of course, but there is one clear finding on what drives it: the share of taxation in government revenues. The higher this is, the greater the drive for democratic representation. In addition, the Norwegian expert commission has highlighted the ways in which economic and financial exposure to tax havens can promote corruption and impunity, undermining standards of governance.

An effective tax system is also key to containing inequality. Direct taxation in particular is both the most important element of progressive taxation, and most powerfully challenged by illicit financial flows. National and international measures to combat the latter are key to facilitating the former.

The agenda of the Task Force is central to the eradication of poverty – the poverty of the 21st century, which is increasingly located in middle income countries and driven by inequality. To support the economic policies that can challenge this, effective taxation is required. To support the political processes needed, effective taxation is an important instrument of democratisation, while challenging illicit financial flows is necessary to overcome governance challenges.

Written by Alex Cobham

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